Technical Trading with Demand and Supply

Videos

2010-09-15T08:06:00.001+01:00

I am aware the videos are now missing., the host has vanished from the web. I will have to record some new ones, that will be fun!

10. Risk Reward Ratio

2010-07-14T16:51:00.002+01:00

Much misunderstood is risk/reward, yet it can be your perfect ally.

You know by now just how unpredictable the market is, you have learnt that trying to predict what is going to happen next is more difficult than you thought. Your percentage of winning trades is much less than you had hoped for and you are barely making a profit. If you are not practising a good risk reward ratio then this brief article may help you turn a corner.

Just to be clear, a risk reward ratio (RRR) illustrates the relationship between the amount you are risking in your stop with the amount you expect to gain in profit at your target. So if you are aiming for a profit of 40 pips with a 40 pip stop behind your entry then the RRR is 1:1. I look for trades with a RRR of 1:2+ i.e. a profit target at least twice the size of my stop because with this level of RRR, you only need to win 33% of your trades to break even, anything above 33% is profit. Suddenly your % of wins doesn't look so hopeless does it?

Let's look at some numbers to illustrate this: -

Using a 25 pip stop and 50 pip target to give us a RRR of 1:2 over 12 trades.

Winning trades 4 (33%) x 50 pips = 200 pips profit

Losing trades 8 (66%) x 25 pips = 200 pips loss

Break even, simple.

Using a RRR of 1:1 or less (yikes!) means you are depending entirely on your trading edge to grow your account. There are plenty of trades with RRR 1:2+ every day, why take anything less?

To avoid reducing your overall RRR it is also best to avoid the temptation to close trades early, covering the last loser or getting spooked by a retrace are classic examples. If you get into the habit of interfering and exiting because of fear or greed you will be back to 1:1 and below in no time. The only way forward is to make it count over a large number of trades.

Trading multiple lots and taking partials also skews RRR, so if you regularly do this you must ensure that the trade has the appropriate potential.

For example: -

Our trade with a 25 pip stop x 2 lots must now have the potential to travel much further because :-

Risk @ 25 pips x 2 lots = 50

Taking 1 lot partial profit at +25 means the second lot needs to go to +75 to preserve 1:2 RRR.

These are of course simplified figures but hopefully the impact is clear.

9. Channels

2010-03-18T15:58:00.005Z

A very short video on channels.

8. Locate Rate and Participate

2010-02-12T08:15:00.003Z

“When executing trades, plan them out vigorously. Delve into any relevant information you need in order to make an informed decision, and take only the trades which fit into the framework of your profitable trading strategy. Lack of proper planning or learning to take trades based on weak or fundamentally incorrect information, or worse yet, “hunches”, is a quick path to failure. A lot of independent money gets lost due to a lack of proper planning.” – SteveW

Wise words from an experienced trader. As far as I am concerned pretty much everything you need to know to trade support and resistance is in BRV's pdf and on www.nobrainertrades.com.

Looking for confirmation and validation of our s/r levels is just as important as picking the most visually obvious price entry points in the first place. However whether a trade is a winner or a loser, all too often we cannot accurately answer the question, “Why did I take that trade?”

If like me you create a daily plan you will find it easy to incorporate actually rating your upcoming price levels based on other confirming factors into your routine. Recording that rating is critical, whether you have a written plan, an excel spreadsheet or simply add the rating to your charts, recording the probability rating has two major benefits.

Firstly, when price finally arrives at xxxx price (which may be several hours or even days later) you can very quickly see exactly why you were so keen on that level and take the trade without hesitation.

Secondly, rating system records help with post trade analysis and provide a simple way of fine tuning your trading strategy.

My approach is really quite crude and unscientific as the scale has no definitive calibration, but for arguments sake let’s say each confirming condition like a trend line or Fibonacci level is worth 10% (you may want to add greater weight to the more significant factors).

Therefore roughly speaking a trade that has seven confirming factors could be said to have a 70% probability.

As with all the other aspects of trading this is open to interpretation and you should really adapt this principle to what suits you. One thing is certain, the more confirmation we get the higher the probability of market consensus and it is market consensus that we crave for very best reversals and break outs.

These are some examples of what I look for: -

SBR/RBS - Support becomes resistance and vice versa.

TF - The higher the timeframe the more significant the level. This can also help us in our trade management. As trades taken from short term s/r will generally have a shorter run.

00 - Round numbers. We're human we like them. (traders are human too!)

23/38/50/61/78 - Fibonacci. Levels from two different timeframes can double the confirmation.

R -Reaction. How did price behave last time it was here? Wicks at a swing high/low or a strong break out suggest a strong reaction this time too.

S - Space. A nice big arc gives us lots of space and time around our trade.

TL - Trend lines are also s/r so they can be used on both sides just like horizontal s/r.

BB - Bucket bottoms. A favourite of mine, bucket bottoms are a point of very strong former s/r. SBR/RBS is here too.

SB – Spike base. See nobrainertrades.com for an explanation.

HS – Head & Shoulders

QM - Quasimodo

FB – Fractal base

GY – Gartley

and so on, you could add or substitute your favourites.

There we go that's more than 10 conditions so you could say:-

USDCHF 11780-11831
SBR
TF
00
78
R
S
BB

We could call that 70% at least.

One final point, if possible I try to have set ups like this in both directions for the pairs I trade, that way despite my bias I have a bit more of a neutral approach to the market and I am more prepared for unexpected changes in sentiment.

For those that queried what the codes are on my charts - now you know.

As always criticisms and suggestions are welcome.

7. Entry Formula

2010-02-12T07:32:00.003Z

How many times has price missed your entry by 2 pips? Ever been stopped out by 2 pips and wished you had entered at the back of your zone instead of the front? Here are a few suggestions to help avoid this.

An entry formula takes the guess work out of picking your exact entry price and allows you to catch any early turns but not let it compromise your stoploss position too much. Of course spreads affect the order fill as it is the sell price that must get hit in order to put you into a buy and vice versa. In my opinion just accounting for the spread is not enough so I add a little extra on too in case there is early selling ahead of s/r because of pending orders.

From a level like 16400 I might deduct 5/10 pips for any early turn and then half the spread to give me the mid price as it appears on my charts, so my entries are either:-

16394 which is -5(-0.5xSpread)

or

16389 which is -10(-0.5xSpread)

Which of these I use and whether I take them from the front or back of my trading zone depends on a few more factors:-

Trend trades and bounces off a formerly flat level e.g. bucket bottom or fractal tend to suit the front of a trading zone and the +/-5(+/-0.5xSpread) set up.

Counter trend trades and bounces from levels where price was V shaped are likely to go deeper into a zone so the back of the range would be more appropriate.

Similar to the above, price action and momentum on the final approach is also a good guide as to how deep price may penetrate.

Finally I will generally place an order earlier on levels from a higher timeframe. As I have already said in this blog you will often see price reverse 10-20 pips short of a daily level.

Profitable trading is a result of repeating a successful method over and over, planning your entries is an important part of that.

The distribution of orders means that price will rarely bounce to the pip, but there are a number of variables at work here so I suggest testing these principles out to find out what works for you best.

6. Abbreviations

2010-01-20T11:05:00.011Z

For simplicity I use a lot of abbreviations when I talk about trading conditions: -

HS - Head + Shoulders
IHS - Inverted Head + Shoulders
QM - Quasimodo
IQM - Inverted Quasimodo
RS - Right Shoulder
HL - Horizontal Line
TL - Trend Line
TT - Trend Trade
CT - Counter Trend
SBR - Support Becomes Resistance
RBS - Resistance Becomes Support
TF - Time Frame
00 - Round Number
T+S - Time & Space
PDH - Previous Daily High
PDL - Previous Daily Low
BB - Bucket Bottom
PB - Pin Bar
SB - Spike Base
TW - Tweezers
RRT - Rail Road Tracks
S/R - Support & Resistance
B/E - Break even
PRT - ProRealTime
BO - Break out
FL - Flag
DT - Double Top
DB - Double Bottom
TDA - Top Down Analysis
TLA - Three Letter Acronym!

5. Trading Zones

2010-01-19T19:06:00.005Z

We discuss exact price levels a great deal, but like many traders whenever possible I try and define a target zone or small range inside which I might enter a trade. A reversal rarely happens at an exact level so I have found this to be good practice, especially when I am watching price action as well.

The easiest way to do this is to use the candle wicks from the last time price was at this level so that the tip of the wick and the candle body become your target zone, if one exists last time price was at the level.

My preferred method results from using the top down analysis described in the last post. I often end up with these ranges defined for me by levels from different time frames by the time I get down to the 1 hour chart.

In the EURUSD chart above, my target area 14446-14455 circled in blue, was defined by the lower, thinner 1 hour s/r level and the upper, thicker 4hour level. An entry any where between these two would have made me happy. Unfortunately a poor news report on top of existing economic pressure made price fall much earlier.

Wider ranges defined by multiple levels can be more difficult to deal with, and a concious decision has to be made as to whether an entry is better at the front of the range or the back. There are many theories on this, some say the front of a range is better when entering a trend trade and the back is better for counter trend. Similarly the front may be better if you are using a flat pattern such as a bucket bottom. Momentum and price action needs to be considered as well so I suggest you study this and come up with your own ideal combinations.

The other important point is that I almost always make an adjustment to my entry to take into account the spread and a small price shortfall. So when I say the back of a range it will usually be a few pips away.

4. Identifying Demand and Supply Levels

2010-01-18T16:54:00.001Z

Top Down Analysis - this is the industry term for what I do, work from the higher time frames downward placing demand and supply levels as I go. By the time I have finished my key TF of 1 hour it should all make sense.

I'm sure you are already actually very proficient at placing your levels but you want to be able to do it better and identify the levels that really matter. Well the main problem is that demand and supply is everywhere and it is easy to cover your charts with lines, unfortunately most of this is just noise that hides what is really going on. Starting with the highest time frames first helps cut down on this noise and allows us to know which TF the level comes from - critical when you are trying to judge an entry or work out how long the reversal might take to complete.

It is often said, the higher the time frame the more significant the level, but also the higher the time frame the wider the influence that level can have. It is possible to get into a trade right at a 1 hour level, but how often does price reverse 15-20 pips away from a daily level? Everything is scaled up, a swing trader using a daily chart aims for hundreds of pips per trade, has a much larger stop than us intraday traders and would think nothing of entering 15-20 pips away from a price level because he/she doesn't want to miss the bus. To reflect this I now use lines of different thickness for each time frame instead of colour coding them to remind me that higher TF levels are more ambiguous.

Here is a short video showing a simplified version of what I typically do to set up my charts for a trading session.

The embedded video has been a problem so if it doesn't work

Click Here

3. Principles of Trading Demand and Supply

2009-12-07T10:29:00.004Z

These early articles may seem a little obvious and basic to some of you, but something I have noticed is that we often have trouble discussing a subject because we have all started from different points and most of us have gaps in our knowledge. Because of the way that learning resources are recorded and distributed, our journey is often a circular one. Here I am trying to keep things a little more linear.

In the article 'So you want to trade Support and Resistance?' I explained that demand and supply levels are likely trading points because of clusters of orders (or people willing to enter the market) causing an imbalance in demand and supply and rapid movement in price. So having altered our approach to thinking in terms of demand and supply, we need to put that in perspective in terms of order flow in the market. Genuine belief in the principle of demand and supply will be much more useful to you than belief in the more experienced traders who use this method!

There's no point me recording a video about this when Sam Seiden tells it like it is!

http://transcripts.fxstreet.com/2007/11/supply-and-dema.html

The next article will be Identifying Demand and Supply Levels.

2. Closes Matter

2009-12-02T18:23:00.006Z

This is something I say a lot.

How many times have you seen a nice solid bullish hourly candle collapse in the last few minutes and leave you with a bearish pin bar (hammer)? The fact is all pin bars or candles with long wicks at some point looked solid and supportive of the trend.

Closes matter.

Although a candle does tell us what is happening while it is active, the final shape is what is really critical. If price collapses then the highs (or lows) were at a level where demand and supply was imbalanced, it is therefore less likely that the trend will continue. So if this happens at one of our predetermined significant demand or supply levels, then we are seeing what we want to see, where we want to see it.

This is applicable to all time frames and is the basis upon which most traders operate. I have an alarm set to remind me of all the H4 closes so that I can check to see how we ended up and get a view as to how H4 will affect the other time frames.

The other time closes matter is in conjunction with time frames. It is important to know the correct TF for each demand and supply level, because only then do you know where to look to see if price closes above or below the level.

There will be a section on The Basics of Price Action later on.

1. So you want to trade Support and Resistance?

2009-12-02T10:16:00.011Z

To be successful you need to understand what you are working with, the first step is to is to think of it in more appropriate terms.

When you say or hear Support and Resistance, think DEMAND and SUPPLY.

Support is DEMAND (people willing to buy), resistance is SUPPLY (people willing to sell).

It may sound obvious, but thinking in terms of demand and supply will help you understand the trading principle that you are trusting with your money.

To really see the story behind the charts it is easier to first study how demand and supply works with a stock or commodity where there is only one item to be bought or sold unlike a currency pair where there are effectively two.

Why Does Price Move?

In simple terms not everyone is willing to buy and sell at the same price. If we were, our charts would just be horizontal lines!

Imagine that you want to buy a sports car. In the weekly classifieds there are six identical examples of the car you want, three are for sale at £10,000, one is £11,000, one £12,000 and one £13,000. Naturally you first phone up after the £10,000 cars first but find that they have all been sold. The number of sellers willing to trade at this price had been exhausted, so the price of this sports car model this week has just gone up to £11,000 because this is the next price at which there is someone willing to sell. You phone up after the £11,000 car and guess what?

Yes, it has also been sold and price goes up again to £12,000. Desperate to have one of these cars before price goes up out of your reach you buy the £12,000 car. To get what you wanted you had to pay more than you had expected to because demand was greater than supply at £10,000 and £11,000, we could assume that the next buyer would have had to pay £13,000 that week.

This example illustrates why price goes up, in a similar way, when there is more supply than demand prices have to fall to find buyers willing to trade.

Why is a Demand or Supply level likely to work?

These are the areas where there are likely to be clusters of orders in the market that will cause an imbalance between demand and supply and therefore a movement in price. The greater the imbalance the faster price could move.

Before you bought your car, prices had been steadily rising for some time. The week following your purchase, prices for this sports car again fluctuated between £10,000 and £13,000 and continued to do so for some time creating a dealing range or consolidation zone. You realise that this isn’t the car for you after all and decide to sell. You look at current prices and realise you can probably get almost all of your money back, but before you can find a buyer a bad report in the press cause prices to tumble to £5,000 before recovering to £8,000 and these figures form the new dealing range for several weeks. Not wanting to sell at a big loss you feel trapped into holding onto your car in the hope that prices recover in the future. Eventually, after the bad news report is forgotten about, prices finally rally back up to £10,000.

Even though this is £2,000 less than you paid and the bottom of the price range where you bought, you grab the opportunity and sell. So do all the others who were also trapped by the impact of the news report and prices tumble from £10,000 once more as the market is swamped with supply.

Everyone who sold from this level traded from the bottom of an inverted bucket, a reliable demand and supply trading set up.